Reasons Self-Employed Homebuyers Get Rejected by Traditional Lenders

Many self-employed professionals earn a six-figure income yet can’t qualify for a mortgage. Consider the freelance consultant who earns $150,000 in one year. Or the business owner who enjoys great cash flow and deep pockets. The real estate investor who earns consistent returns from their holdings. They appear to be qualified borrowers, yet to the bank, they’re somehow “unqualified”.

The question is not whether they could afford to repay a loan. It has to do with a misunderstanding of how self-employment income actually works compared to how conventional underwriting evaluates it. That’s why it’s vital to understand what triggers a rejection, so you can plan more effectively.

Tax Deductions Kill Your Qualifying Income

When self-employed individuals file their taxes, they can legitimately deduct expenses they incur, such as a home office, car use, equipment, software, and insurance. This makes perfect sense, but mortgage lenders are only interested in their net income, which is the bottom line after deducting expenses.

A freelancer grossing $200k might claim $80k in legitimate expenses, leaving the IRS with $210k of net income from self-employment. A traditional lender is not going to consider the $200k. They’re going to consider the $120k, and they’re going to blow off your application because the income isn’t sufficient to support the loan amount you need.

This is where options like stated income home loans completely shake up the way lenders examine your finances. Rather than penalizing you for being smart with taxes, alternative loans examine actual business income and bank deposits. The stated income loan program considers what you really earn and bring home versus what is left after legitimate deductions designed to reduce your tax burden.

Multiple Income Streams Create Evaluation Confusion

A common issue for self-employed individuals is that they rarely generate income from a single source. You may receive income from your primary business revenue and rental income, or maybe you make money by charging consulting fees and investment returns. Maybe you receive income from 1099 contract work, a part-time W-2 job, as well as some freelance work.

Traditional underwriting is simply not set up to handle all of this complexity quickly. There’s paperwork for every source of income. Some sources get reported, others get questioned, and a lender’s systems automatically fall back on a “conservative” approach when they don’t understand something.

For instance, a lender might simply decide not to count recent sources of income because they don’t have a two-year history, they might apply huge discounts to variable sources of income. The end result is that your overall income appears a lot weaker on their spreadsheet than it actually is, making it difficult to qualify for a home loan.

New Businesses Often Have Limited Tax History

You’ve been in business for 18 months. Your business is profitable, generates consistent revenue, and you make consistent deposits into your business checking account. On any fair measure, you make a good loan prospect.

However, the banks demand two years’ worth of business tax returns. Since you don’t have two complete years of documented history, your new business automatically doesn’t qualify. This is a frustrating catch-22 situation, making it harder for new businesspeople to secure loans to purchase homes despite their solid financial history.

Endnote

The problem with most rejection reasons is that traditional underwriting criteria view self-employed individuals from a W-2 employee perspective. If you don’t fit the criteria from that perspective, you will be denied approval even though you’re actually qualified. This is why it’s vital to take advantage of modern alternative lending options that don’t skip over your taxes and compliance. Be sure to research your options before you apply for a home loan.